Evil Business Models: Turning The Dollar Auction Into A Profit Center

from the human-psychology-at-work dept

On my very first day of econ 101 as a freshman in college many, many years ago, my professor played a "game" with two students in the class in order to demonstrate how incentives can lead to bad outcomes for everyone. He held up a dollar, and told each student that they were competing to "buy" the dollar. However, rather than a standard auction, both parties had to pay whatever their final bid was. Thus, even the loser has to pay. This leads to screwed up incentives, where things quickly spiral out of control. At first, one student will bid a penny, and of course the other student will bid 2 pennies. In both of their minds, it makes sense to bid up to $1 to get $1 back. Except... once you hit $1, the other student doesn't want to lose, knowing he's going to pay out without getting anything back -- so the bidding zooms past $1, with both participants knowing that they're going to lose money, but wanting to "win" in order to make sure they don't lose as much as the other one. In the end, the only one who makes out well is the econ professor who collects the money from both students and only has to pay back one dollar. I think in my year, he ended up making $3 or $4 before the students gave up, realizing things were only going to get worse. This is apparently a popular exercise in a number of econ classes, called the Dollar Auction.

However, it looks like some enterprising or evil students who played (or observed) that game have decided to build a startup on the same principle, where they (of course) play the role of the econ professor, and everyone else becomes the suckers who are eventually forced to overbid to minimize their losses. Tom sends in a link to a description of how swoopo works, and it sounds very much like the dollar auction. Basically, you purchase "bids" and each bid you place increases the purchase price of an auction and extends the auction a little longer. In other words, everyone keeps paying, hoping that they'll eventually get the "good" offered for sale at lower than face price. But, of course, like the dollar auction, because of the competition, the incentives get set so that people are likely to keep spending to get something back for their bids, rather than nothing at all. Swoopo is slightly more insidious in that the "price" of the item increases at less than the cost per bid, such that the price of the item stays lower than its list price for a long time, even though many people bid on it. That creates a scenario, as described in the post, where users of the site end up shelling out a grand total of $1,125.90 to the company, for an 8GB iPod Touch that lists at $229. Most of the bidders end up with nothing... and only one got the Touch for $187.65 plus whatever money he spent on bids.

While you have to be impressed with the sheer obnoxiousness of the business model, you have to wonder how long it can last, once people start to realize that the only winner is the company itself, and most of the "buyers" turn out to be big, big losers. The dollar auction works great if you play it once... or if you can keep finding suckers. If the suckers recognize that they're suckers, things dry up quickly.